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A Subprime Fix From Fannie and Freddie

Fannie and Freddie offer subprime help.

Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) made progress on their recent word that they would offer new subprime products when top execs from each government-sponsored enterprise testified on Tuesday before the House Financial Services Committee.

Fannie discussed a new three-pronged initiative, dubbed "HomeStay." The program involves working with lender partners to help homeowners stave off immediate foreclosure through financial incentives and workout solutions, expanding lending options to help refinance subprime borrowers out of ARMs and into long-term fixed rate products, and counseling future homeowners about making appropriate mortgage choices.

Freddie spoke about restricting subprime investments, eliminating no-income, no-asset verification loans ("liar loans"), and urging subprime lenders to escrow borrower funds for taxes and insurance. The GSE also announced the midsummer introduction of more consumer-friendly subprime mortgages in the form of 30-year and possibly 40-year fixed-rate mortgages and ARMs with reduced margins and longer fixed-rate periods. Freddie also called upon regulation that ensures uniform and consistent consumer disclosures.

Going forward, a combination of increased consumer education and regulation restricting predatory practices is vital. Certainly, swapping out of an ARM and into a long-term fixed-rate mortgage makes sense for most subprime borrowers. But while these suggestions are commendable, they will not serve as a panacea for all existing subprime ills. With close to 2.4 million homeowners facing default on their subprime mortgages over the next several years, foreclosures will mount despite sensible refinancing options and increased financial awareness.

Nor should Fannie and Freddie be charged with curing the system. Given their blemished accounting records, the GSEs provide easy targets for retribution by politicians seeking to capitalize on public clamor for subprime reform. Fannie and Freddie should not bear this blame. In the same congressional testimony, Fannie counted less than 2.5% of its business as subprime, and Freddie reviewed a litany of unilateral, voluntary steps taken since 2000 to improve subprime practices.

As Congress continues to debate regulation of the mortgage finance giants, it would be wise to bear in mind that the missions of the GSEs is to enhance liquidity, stability, and affordability in the housing market. Fannie and Freddie demonstrate their commitment to that goal, and should not be regulated as a proxy for the irresponsible practices of certain subprime mortgage lenders. While internal housekeeping issues at Fannie and Freddie remain, one hopes that regulatory measures will not be imposed which will hamper their ability to responsibly and flexibly meet the needs of the market.